Question

Stock R has a beta of 2.5, Stock S has a beta of 0.85, the required return on an average stock is 12%, and the risk-free rate of return is 4%. By how much does the required return on the riskier stock exceed the required return on the less risky stock

Answer 1

The difference between the riskier and less riskier stock is 13.2 percent.

Step-by-step explanation:

Given that the stock R has the Beta = 2.5

The stock S has the beta = 0.85

The required return on the average stock = 12%

Given risk free rate of return = 4%

Now calculate the required return by using the below formula:

Ke = Rf + B (Rm - Rf)

Rf = risk free rate of return

B = beta

Rm = market rate of return

Required return on riskier stock =
`4 + 2.5(12-4) = 24%`

Required return on less risky stock =
`4 + 0.85 (12-4) = 10.8%`

Now the difference between the both risk = 24 % - 10.8% = 13.2%